The Expectations Hypothesis of Term Structure of Interest Rates in Taiwan’s Money Market

This study investigates the expectations hypothesis of term structure of interest rates in Taiwan’s money market by examining six short-term instruments during the period for which monthly data are available (from Jan. 1994 to Dec. 2005). The six instruments studied are 30-, 60-, 90-, 120-, 180-, and 365-day commercial papers, respectively. This study argues that the unsound government bond market and the existence of tight interest rate controls in Taiwan’s market could lead to the violation of the expectations hypothesis. Using GMM to test the term spreads, this study finds that the expectations hypothesis is not suitable for application to all rates. Furthermore, the modified version of the expectations hypothesis that incorporates the time-varying term premium in the Taiwanese money market cannot be applied by any rates, that is, term spreads could not accurately predict future short-term rates. The empirical results are valid for both subperiods as well as the whole period.